What if HMRC wants to run an IR35 compliance check on your contractors?

Ever wondered why HMRC switched the responsibility for IR35 compliance to public sector and private sector employers and away from contractors?

And want some clarity on what happens if you declare your contractors as outside IR35 and HMRC disagrees?

In this article, especially written for employers, we’ll share with you:

• What went wrong with the old system from HMRC’s perspective

• Why off-payroll working rules were changed in the way they were

• How the officially-sanctioned HMRC Check Employment Status for Tax (CEST) tool may be your biggest potential compliance Achilles Heel

• How HMRC will tell you they want to check the tax status of your contractors

• What happens if they decide you’re wrong and how you should respond

• Turning your workplace into an outside-IR35, contractor-friendly workplace to save money and attract the best talent

For more information on IR35 compliance for employers, please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.

Why employment status became a thing with HMRC

Twenty-plus years ago, HMRC was looking for practical solutions to what they called the “Friday Monday phenomenon”.

A salaried member of staff would leave their job on a Friday afternoon and start work again doing exactly the same job under the same working arrangements on Monday morning as a contractor.

Ex-staff members would operate through their own intermediary companies to reduce the amount of tax they and their former employer would have to pay. The era of limited company contractors was born and it thrived particularly in the financial services, oil and gas sectors, healthcare sector and beyond.

This has been going on for four decades and more. HMRC decided at the end of the millennium that they wanted to put a stop to it. They believed this was a wilful misclassification of employment status on the part of contractors and clients for the sole purpose of evading tax.

For all parties involved, there’s a lot at stake. Contractors and employers don’t pay income tax or make National Insurance contributions if the relationship is that of customer-supplier and not employer-employee.

HMRC is losing billions because of this. They want as much as possible of it back so they do everything they can to deter contractors having self-employed status when working for clients.

Why it’s now up to you to determine a worker’s employment status

Look at it from HMRC’s perspective. If they had launched special tax rules to cover professional footballers in England and each team had 24 players on their books, their investigative resources would have to stretch to cover 2,784 players.

However, by targeting the clubs instead of the players, HMRC only has to stretch their resources across 116 targets.

It makes much more sense for them to do this with contractors as well. Contractors number in the hundreds of thousands across the UK.

And many contractors have been on the end of an IR35 compliance check before. They know what to expect and how to defend themselves.

The same can not be said of clients who had little to no exposure to compliance checks until the rules changed in 2017 and 2021.

So, instead of chasing 100,000s of contractors who know what to do when challenged, they would target a few thousand companies who’d always relied on their contractors to do the work for them.

HMRC’s sting in the tail with the new off-payroll working rules

But it gets even better for HMRC. Under the new off-payroll working rules, the financial risk is entirely shifted across to the employer.

Let’s say that your company engages 25 contractors all outside IR35. If HMRC then comes along and tells you that they’re, in fact, all within IR35, you’ll have to pay the income tax, National Insurance contributions (both versions) and Apprenticeship Levy (if applicable) for each contractor at the end of the tax year with a deemed payment.

On top of that is a system of fines. Those fines escalate according to the lack of reasonable care HMRC judges that you undertook with each individual contractor’s status determination statement.

Why HMRC’s CEST tool was not fit for purpose for worried employers

HMRC offers a tool for employers to check employment status for tax purposes – the CEST tool.

It’s popular. It was used 1,837,488 times between 25 November 2019 to 31 August 2021, 1,092,979 times by employers like your company.

There are a number of problems with it though.

First, it’s rubbish. The code behind the tool has been buggy since 2019 and, at the time of writing, has not been fixed.

Second, it’s often unable to make a determination on IR35 status. In around a fifth of cases, it is inconclusive after you have answered all of its questions.

Third, it assumes no mutuality of obligation at all, one of the most important IR35 contractual terms.

Last, HMRC won’t stand by the result, despite claiming it does. HMRC collects no records of your or any other employer’s IR35 compliance checks. If CEST says that you’re clear and HMRC says that you’re not, they will just say that you did the test wrong. They’ve said that direct to many employers and it’s their standard line of defence at a First Tier Tribunal service too.

It’s no surprise that many in the accountancy profession were recommending that employers declare all contractors within IR35 or that they use an umbrella company for contractors with CEST being so poorly executed.

How HMRC notifies you that they’re doing IR35 compliance checks

You receive a letter from HMRC with the headline “Applying the off-payroll working rules – effective from 6 April 2021.”

They’ll tell you that they want further information on your processes and systems for ensuring adherence to IR35. They’ll want to check that you’re correctly applying the current law and they’ll look for areas of potential non-compliance.

You probably won’t receive a visit at first. They offer the option of carrying out the consultation over the phone or in writing. We recommend choosing written communications first because the process takes longer and it gives you more time to gather the evidence you’ll need in your defence.

If HMRC is happy with what you provide them on your recruitment processes and how you determine employment status on direct and indirect hires, they tell you that they intend to take no further action and leave it there.

How to react if HMRC wants to investigate further

Just because HMRC says that you’re wrong doesn’t mean you are wrong. HMRC has suffered a significant number of defeats in recent years at HM Courts’ First Tier Tribunal service at the hands of contractors wrongly accused of misdetermining their employment status.

It can take up to three years between the start of an investigation and its conclusion. It’s in your best interests to close it off early with the right result rather than let things become protracted though.

Keep copies of all your contracts, your contractors’ timesheets, details on where they worked and what they worked on and more. The more evidence you have, the harder it is for HMRC to challenge your outside IR35 status determination.

Get help from your contractors too. Ask for evidence about other employers they worked for (invoices, timesheets and so on), when they brought substitute staff in to do the work, copies of their business insurance agreements and more.

Be prepared to stay in the fight for a while and take this opportunity to get in touch with an IR35 specialist like CoComply to help you with your defence.

We help public and private sector clients stay on top of contractor IR35 tax status

It’s worth taking the extra effort to declare your contractors outside IR35. Not only will it save you and your contractors a lot of money but it will also help you attract the top talent sick of having their pay docked by greedy umbrella companies.

It all starts with an IR35-compliant contract (resist the temptation to use outside IR35 contract templates at all costs) and continues with accurate record-keeping and working practices checks. Chartered accountants are great at financial reporting but they’re not IR35 specialists – listen to the specialists.

Contact CoComply today about ensuring compliance for your current and future contractor workforce.

For more information on IR35 compliance for employers, please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.